The Advantages and Disadvantages of Debt and Equity Financing
Business owners have options when it comes to financing. However, as with anything, there are both advantages and disadvantages to all kinds of financing. Debt and equity financing, are no different. However, a thorough understanding of how both forms of financing work can help you to determine which one might be best for your business.
Debt financing is associated with financing that you acquire on your own without the help or investment of others. This includes funding sources like credit cards, home equity loans, and personal loans, even your savings. This type of funding is often used by people who want sole ownership of their business and don’t want any other companies, people, or businesses to have a stake. This type of financing is beneficial in that you don’t have to give up a percentage of your company or share ownership. You are the sole owner. Plus the interest you pay on any loans is tax-deductible, which can be a perk. Conversely, some of the drawbacks associated with debt financing include:
Negative effect on credit
Increased debt to income ratio
It’s often necessary to weigh the pros and cons of any type of financing. Look at your goals, assets, and unique situation to determine if debt financing is a viable option for you.
You may have friends, family, and business partners willing to invest in your business as more than just financial lenders. Perhaps, they want a stake in your business or a percentage of the profits. This is called equity financing. When people choose to provide funding for your business venture but would also like some kind of return on their investment. There are benefits to equity financing that include the avoidance of loans through financial institutions with stringent eligibility requirements and guidelines. In addition, a business prospectus may create more flexibility and understanding when and if your business fails. Your investors may be more understanding and flexible regarding their return on investment or ROI. Negative aspects of this type of financing include:
You share your profits
Investors have a stake or percentage of ownership
There is no one size fits all answer when it comes to which form of financing is best. When it comes to both debt and equity financing, no one form of financing is good for everyone. You will have to look at your wants, needs, preferences, and the unique drawbacks and benefits of both forms of financing. Your unique situation should be used to determine which form of financing is best for you.